REI Capital Group

I've recently began doing some real estate investing and I've set up a site for my LLC.

http://www.reicapitalgroup.com

Problems with End the Fed

Our well-meaning friends in the Ron Paul camp have some incomplete ideas about economics and money. The genesis of this post was a post on a FreedomWorks blog, http://julieborowski.wordpress.com/2012/02/01/top-10-reasons-to-end-the-federal-reserve/. I believe this is a fair representative of the Ron Paul and his supporters supporters. As the Ron Paul movement gains influence, addressing the bad or unsubstantiated arguments will be very important. I have not answered all of the arguments in the post, but I addressed most of them and some are fairly similar to one another.

• The Federal Reserve Has Significantly Devalued Our Currency

"Since the Federal Reserve came into existence in 1913, the dollar has lost over 95 percent of its value. Today’s dollar is worth less than a nickel compared to the pre-1913 dollar."

This is true, but so what. This is a big problem if you kept cash under a mattress. 95% in value over a long period of time isn’t cause for concern, 95% in one year that could cause some problems. In any event, I do not keep large amounts of cash on hand. I put it into assets that earn a return over the rate of inflation.

• The Federal Reserve Hurts the Poor and Middle Class the Most

" But higher prices are actually a direct consequence of inflation since increasing the supply of money decreases the purchasing power of the dollar. Inflation hurts the poor most since they have less disposable income. Consumers with low disposable incomes will be negatively impacted by higher prices for food and clothing."

Simply not true. Inflation does not hurt the poor most. Inflation affects people who hold onto cash, and the poor tend to spend money that they earn in short order. The price of labor (wages) tend to rise with everything else so inflation does not erode the purchasing power of wages. An unexpected increase for inflation for a great many poor or middle class people would probably be beneficial. Take the example of a person with a fixed rate mortgage or student loans. If they owe $100,000, that amount stays the same if inflation increases from 2% to 10%.

Hyperinflation hurts the poor insomuch as it hurts everyone with the chaos brought on by unpredictable relationships between prices and in extreme cases money becoming useless as even a temporary store of value.
Inflation does have distributional effects and it does hurt some.

1. Receive a fixed interest rate over a long period of time and there is an unexpected increase in inflation.

2. Make illusory nominal gains through interest or capital gains. If inflation is at 10% and you receive 12% interest you’re outpacing inflation, except that you pay taxes on the 12% gain not the real gain.

3. Companies that are overtaxed because depreciation expense does not cover the replacement value of a capital good as it rises in price


Some countries with high rates of inflation have indexed their tax systems to inflation, so this need not be an ill effect of inflation.

• The Federal Reserve is Run By Unelected and Unaccountable Bureaucrats

"The Board of Governors at the Federal Reserve are not directly elected by the American people. This means that those who run the Federal Reserve are unaccountable to the people. The seven members of the Board ultimately decide the price or purchasing power of our money. That kind of central planning would never exist in a true free market economy."

If we have a central bank involved in money, it should be by unelected and unaccountable bureaucrats. There is a high correlation between the independence of central banks and a low, stable level of inflation over time. It’s the banks that are controlled by the treasury or ministry of finance that should have you more worried. I would be in favor of the central banks of the world using predictable targets such as nominal GDP (NDGP) rather than trying to outguess and out fool the economy.

• The Federal Reserve Has Made Our Economy Less Stable

"The Federal Reserve has brought us endless boom-and-bust cycles. The U.S. economy was much more stable before the Federal Reserve came into existence. It bears significant responsibility for every financial crisis over the past century including the Great Depression, the stagflation of the 1970s and recent economic meltdown. The Austrian Business Cycle Theory explains why we see such wide fluctuations in the economy. The theory states that a false boom occurs when the Federal Reserve lowers interest rates below the market rate which increases the supply of money. Artificially low credit cost sends out misleading economic signals to producers. They are inclined to respond by greatly expanding their production around the same time. In retrospect, these investment decisions calledmalinvestments are seen as a bad allocation of resources. Malinvestments will lead to wasted capital and economic losses. The expansion of credit cannot continue permanently which means that inevitable bust will follow a false boom created by the Federal Reserve."

I don’t think every business cycle or economic bubble post-1913 has been caused by the Fed. The temptation once you have a business cycle theory is to see it anywhere and everywhere. The Internet boom and bust, which was small by comparison but still significant was probably not an Austrian business cycle. It was not fueled by cheap credit. It was fueled by equity investors that were just wrong about valuation.

As for stability before the Fed -- 1819, 1837,1873,1901,1907.

GMU Economist Bryan Caplan wrote an excellent analysis of the problems with Austrian economics

• The Federal Reserve Has Far Too Much Power to Control Our Economy

"Federal Reserve Chairman Ben Bernanke has the power to dramatically impact our economy at a drop of the hat. The central bank completely controls and determines the money supply. It is permitted to create as much money as it wants out of thin air with no restrictions. This is the antithetical to the principles that America was founded on. Our Founding Fathers would be outraged that one centralized institution has unchecked and unprecedented power to control the economy and thus our lives."

• The Federal Reserve is Far Too Secretive

"The central bank severely lacks transparency. Throughout its 100-year history, it has always operated under a veil of secrecy. The Federal Reserve has never been fully audited by any outside source. Our elected representatives in Congress have very little oversight over the central bank. It has continually resisted any kind of congressional oversight claiming that it would endanger its “independence.” A comprehensive audit of the Federal Reserve would not harm its so-called independence. It would only expose how the Federal Reserve has been manipulating our currency behind closed doors. And Ben Bernanke surely doesn’t want that to happen."

If you like inflation, just wait until Congress controls monetary policy.

• The Federal Reserve Benefits Special Interests

"The policies of the Federal Reserve hurt the average American. It benefits the privileged few at the expense of the rest of us. The Federal Reserve erodes most Americans’ standard of living while enriching well-connected elites. The central bank serves big spending politicians, big bankers and their friends. Special interests receive access to money and credit before the harmful inflationary effects impact the entire economy. This is why high power lobbyists protect and defend the existence of the Federal Reserve."

I agree that any regulator is subject to regulatory capture and that benefits the incumbents in an industry. I don't see the evidence that the Fed erodes the standard of living. The inflation argument doesn't cut it.

• The Federal Reserve is Unconstitutional

"The Constitution makes no mention of a central bank. While there have been historical debates on the constitutionality of a central bank, I see no justification for the argument that the Federal Reserve is constitutional. The federal government only has about thirty enumerated powers delegated to it in the Constitution. The power to create a central bank is not explicitly granted to the federal government in our founding document. Due to my strict interpretation of the Constitution, I find the Federal Reserve to clearly violate the Constitution."

To be honest, I'm not sure. I believe it follows directly from the power to coin money. Congress can delegate authority to others provided it doesn't bind itself or future Congresses. Congress delegated this power and they could take it back at any time.

• The Federal Reserve Encourages Deficit Spending

"The Federal Reserve is largely responsible for the out-of-control spending by Congress. The federal government can only obtain money through taxation, printing or borrowing money. Printing money has become the federal government’s preferred method. This is also the most destructive method since the federal government is able to simply print more money as needed to finance its drunken spending spree. It has become a never-ending cycle of spending and printing more money. Voters can put pressure on their representatives to halt politically unpopular tax hikes and lenders could stop loaning money to the U.S. government. But it’s fast and easy for the Federal Reserve to print more money at a whim."

This argument starts with a truth about seigniorage or the profit that a government (or central bank) makes from printing money. This certainly has been significant in some places and times like in Zimbabwe, Argentina and Brazil during the 1980s. Seigniorage the US government makes from printing money is a couple percent of the federal budget.

• The Federal Reserve Routinely Bails Out Big Banks

"The Federal Reserve acts as the lender of last resort. The Federal Reserve was ordered through a Freedom of Information Act request to release 28,000 pages of documents in March 2011. The documents exposed that one of the largest recipients of the Federal Reserve’s money was foreign banks during the 2008 economic meltdown. The top foreign banks that received money were the Brussells and Paris based Dexia SA, the Dublin based Depfa Bank Plc, the Bank of China and Arab Banking Corp., according to Campaign for Liberty. In July 2011, due to a provision under the misguided Dodd-Frank financial overhaul law, the Government Accountability Office (GAO) conducted a one-time, watered-down audit of the Federal Reserve. The GAO investigators were not allowed to view most of the Federal Reserve’s monetary policy decisions including discount window lending, open-market operations and details on its transactions with foreign governments and banks. This first ever audit of the Federal Reserve revealed $16 trillion in secret bailouts to corporations and banks around the world in less than three years. These bailouts happened without a single vote taking place in any chamber of Congress."

The $16 trillion figure includes loans that were afforded on a daily basis. So if a bank borrowed $1 billion for 30 days, we would count this as $30 billion. Not to minimize the dollar amounts involved, but get the facts right first.


Comments welcome.

I'm Back

I have been thinking lately about what Republicans and Democrats get wrong. I will use Republican and Democrat as shorthand for errors more common in the mainstream of the respective US political parties whether politician or rank-and-file party member.

Republicans: Market failures do exist. For example, many industries pollute the environment. Negative externalities should be taxed or property rights should be created and those that can abate pollution least expensively will do so. Basically, you should not get to pollute and externalize all those costs on everyone else even if it is good for a particular industry or "creates jobs".

Democrats: A price you do not like is not a market failure. Gas prices too high, somebody must be gouging whatever that means. Of course, we need to have rent controls to protect those poor tenants. In most cases there was not a market failure to begin with and the "cure" causes the disease.

I have a few more brewing for the Democrats, Republicans, and maybe even a few aimed at Ron Paul and his supporters.

If we don't know how many people, how do we know how many Congressmen we need

I frequently see advertisements on the television and outdoors for the census in the format, if we don't know how many people we have, how do we know how many x we need.
Where x is hospital beds, classroom, trains, buses, etc.
http://www.youtube.com/watch?v=OP2BGqnPQY4

"The census helps us know exactly what we need, so everyone can get their fair share of funding.”

I am disappointed that this appeals to so many people. Have we really moved towards a society where we fill out a survey so the government can calculate our needs?

Of course, the primary purpose of the census to apportion Congressional seats and Electoral College votes among the several states by population. I believe that is an important enough reason to mail it back. This representative form of government is at least as important as the government handing out goodies from the fraction of people that pay the bulk of the taxes to everyone else.

Speech in a Free Society

Everybody knows there is tons of money in politics. It is a natural consequence of the government regulating and controlling more parts of the economy. P.J. O'Rourke said, “When buying and selling are controlled by legislation, the first things to be bought and sold are legislators.” I am not writing to defend or advocate a particular size and scope of government in general. There was a Supreme Court decision regarding political speech recently, FEC v. Citizens United.

Background

Citizens United produced “Hillary the Movie” that said she was a power-hungry viper unfit for the presidency. They wanted to make this available in theaters and through video on demand systems.

Analysis

You would think that they would be free to distribute this move however they saw fit in a free country. However, the Bipartisan Campaign Reform Act of 2002 did not permit “issue ads” 60 days before a general election and 30 days before a primary election. Issue ads simply take a position on some policy and typically associate a candidate for or against that policy. The law called for heavy fines and jail time for daring to speak out in a way that the law did not permit. So, basically this prohibited an organized group for people from making political statements.

In the recent case FEC v. Citizens United, the Supreme Court struck down major parts of BCPA. Anthony Kennedy in the majority opinion writes,

“Thus, the following acts would all be felonies under §441b: The Sierra Club runs an ad, within the crucial phase of 60 days before the general election, that exhorts the public to disapprove of a Congressman who favors logging in national forests; the National Rifle Association publishes a book urging the public to vote for the challenger because the incumbent U. S. Senator supports a handgun ban; and the American Civil Liberties Union creates a Web site telling the public to vote for a Presidential candidate in light of that candidate’s defense of free speech. These prohibitions are classic examples of censorship. “

While most have an idea that censorship is bad policy, he gives a great reason why we should not censor political speech, “speech is an essential mechanism of democracy, for it is means to hold officials accountable to the people.”

The content of the speech was not so much at issue as was when it was going to air and who sponsored it. I agree with the majority opinion that the identity of the speaker does not determine rights. Just because a group is too influential that is not a justification for withholding First Amendment rights.

Not everyone agreed with the outcome of this case, in fact it was a 5-4 decision. In a weekly radio address, President Obama said, “this ruling strikes at our democracy itself.” While some are worried about the outcome of this decision and perhaps justifiably so. However, a law cannot be upheld because it produced good outcomes or invalidated for bad outcomes. The Court rules on the law with the Constitution as the highest law in the land.

As a practical matter, political free speech is necessary for a functioning republic and it is exactly what was intended to be protected whether it's the ACLU arguing against the Patriot Act, the NRA advocating for less restrictions on guns, or a group advocating for or against abortion rights. And they need to be able to say whether candidate x is right or wrong on these policies whether they are a single person or an association. The life and death of the Republic depends on the freedom to make exactly this kind of speech.

The argument that we are treating corporations as people is a spurious distraction. We are simply saying that individuals are able to pool their resources and can speak in concert. Corporations are not people any more than your car or computer is a person, but the stockholders, directors, and others that control the corporation do have rights. Remember that while Hillary the Movie was funded by a corporation, people made the movie to express views that themselves and other people had. If we argue that corporations or other associations have no rights, do we then allow searches of corporate offices without warrant and cause or arbitrary expropriations without due process?

I believe that the dangers of this ruling are exaggerated. Big media big money speech is losing influence, not gaining influence. Grassroots efforts are being organized via Twitter. Bloggers and news aggregators run from the bottom up decide what is important, and I believe this trend will continue.

The solution to more corporate speech if that comes to pass is more speech from everyone rather than muzzling organized groups and chilling free speech.

Reality Still Matters

An exchange rate held to an unnatural level and prices restricted by government decree are a familiar tune. In Venezuela, some have bolivars and want to buy dollars for their imports. The government has tried to maintain a fictional exchange rate and has rationed dollars, but markets are what arise naturally whether you want them to or not.

Predictably, the Venezuelan government's restrictions on foreign exchange and price controls are not working and these controls are creating problems that they try to solve with yet more controls. More rules cannot repeal reality and they only serve to create corruption, discourage foreign and domestic investment, and slow production. The sellers of goods are understandably reacting to the reality of more bolivars in circulation by raising prices. You can tell people to ignore reality and sell at the old prices, but the historical record is that people are smarter than that and it never works.

Chavez accomplishes his objective of increasing government control exceptionally well. As he is moving so quickly and with quotes like this,“People, don’t let them rob you, denounce it, and I’m capable of taking over that business" it is obvious what he wanted all along. Perhaps the motives of politicians here are more pure, but if something like the Senate healthcare bill passes it will 'require' more controls to fix the problems it creates.

The American Dream

I have been thinking lately in the wake of this real estate bubble, why do people buy homes. Over the past few days, I wrote down a few reasons and some brief commentary.

• At a certain age or after a life event like marriage or the birth of a child, it’s time to buy a house.

Hard to argue with someone’s emotional connection to home ownership, except to say that it is not the way I think.

• Flexibility to remodel and get exactly what you want without consulting a landlord.

I do see a benefit here in being able to customize your living space. While custom build-outs are relatively common in commercial space, rented housing is whatever you can find on the market.

• A forced savings plan

Some people are not good at saving money, and since each month you pay some principal you are effectively saving. This reason does not hold any personal relevance to me as I do save. It is analogous to the person that deliberately seeks to get an income tax refund even though it is giving an interest free loan to the government.

• Pride of ownership

Again, hard to argue with someone’s emotional connection to home ownership, so I won’t.

• A good investment

This is really just speculation on price appreciation, not that there's anything wrong with that. The long term record of housing prices does not show that it is a great investment. Yale Economist Robert Shiller calculated an average of 0.4% / year price appreciation from 1890 to 2000. Mind you, this is for a very illiquid asset with an appreciable amount of volatility.

• Buy into the myth that rent is throwing money away

When you rent you are paying for a valuable service, the roof over your head, maintenance of the property, and often utilities. You’re not throwing money away for that service any more than any other service you buy. In some markets a couple years ago, buying was much more expensive than renting even over the whole term of the mortgage. As compared to buying where you “throw away” money on interest, property taxes, and repairs.

• The types of properties available to rent are less desirable than ones to buy

Varies. I have heard that there has been an increase in single family homes in the suburbs available for rent.

• Concerned about rent increases

A fixed rate mortgage will lock in some of the expenses for housing, but don’t forget about property taxes. Those can move upward quickly in some areas.

• Tax benefit for owner occupied property

The mortgage interest and property tax deductions can help make owner occupied property make economic sense. Remember, these are below-the-line deductions in lieu of the standard deduction. So, you can get a maximum benefit of your expenses * marginal rate.

Anything I missed, please comment.